Fine Print - April 2011

Assessing the corporate tax rate

By G.D. Gearino

In any reasonable era, a year such as 2011 — which is to say, a moment squarely between national election cycles — ought to be politically muted, a time of respite when the partisan troops rest by their campfires and debate the next day’s tactics. But we live in the age of the permanent campaign, so no issue is too inconsequential to be endlessly engaged. Additionally, North Carolina’s state government now finds itself in a budget crunch, meaning costs must be trimmed and/or taxes raised. Put those two phenomena together, and you get the most Orwellian squabble imaginable: the debate over the state’s corporate tax rate.

When it comes to tax discussions, the corporate tax rate is without equal as a political lightning rod. It’s populism, economics, political belief and class warfare bundled together in a single tidy issue. Gov. Beverly Perdue has proposed reducing the rate from 6.9% to 4.9%, and that suggestion sent policy wonks into overdrive. The liberal North Carolina Justice Center, for instance, opposed the cut by arguing, in essence, that as far as the state’s greater economic health is concerned, politicians are the better stewards of corporate profits. (Its exact words: “ ... a further reduction of the state’s available resources will not only be damaging to the state’s public structures but in turn could undermine efforts to create jobs and build a stronger economy for North Carolina’s future.”) Meanwhile, the conservative John Locke Foundation supported the cuts and made the case that the corporate tax rate ought to be abolished altogether. The latter claim only makes me shake my head at the audacity it takes to tilt at that windmill. The first claim, though, leaves me gap-jawed with astonishment: There are people who seriously believe that money confiscated by the political system somehow comes out the other end and pays a premium to the economy?

But these are, obviously, philosophical differences. For all the certainty accompanying the predictions of good or harm that would come with a reduced corporate tax rate, it’s really just theory springing from pre-existing belief. Still, there are two things to factor into the debate.

The first is something called Hauser’s Law, named for the economist who first noticed the relationship between tax revenue and the gross domestic product (which is to say, the economy). Hauser’s Law postulates that no matter how much politicians tinker with tax rates — hikes, cuts, loopholes, exemptions, whatever — the amount of money the federal government collects always stays in the neighborhood of 19% of the gross domestic product. Using that theory as a starting point, N.C. State University economics professor Michael Walden undertook a similar study of the state’s tax history to see whether it followed Hauser’s Law and concluded it does, more or less. For almost the past three decades, tax revenue as a percentage of gross state product has hovered around 6%. The explanation is simple, really: Tax rates don’t exist in a vacuum. Raise them enough, and taxpayers — individual and corporate alike — will find ways to reduce the burden, such as moving somewhere else where the tax burden is lower.

The second thing to factor into the debate is the reflex by state political leaders to bribe companies to relocate or stay in North Carolina. Those bribes, more politely called “incentives,” involve public funds in uncountable amounts. That’s not hyperbole, by the way. Considering that the bribes come from a variety of accounts and programs, and that they’re tied to certain conditions and performance goals, it’s virtually impossible to attach an exact dollar figure to the total. Still, I spent an hour with my online search engine revved up and calculator at hand and easily came up with more than $1 billion of public funds awarded or pledged by state leaders to private business in the last decade or so. And I was just getting started.

Thus we come to the most Orwellian aspect of this matter: The state of North Carolina is taking money from corporations in the form of taxes only to return it to them in the form of incentives. Or to be more precise, it’s taking taxes from small businesses and awarding it to Google, Federal Express, Merck, Citigroup, etc. So, yes, I suppose the people who support the higher tax rate in the name of jobs are correct. We need all the corporate tax revenue we can lay our hands on so that we can give it to companies who otherwise might leave, or not come in the first place, because the corporate tax rate is too high.

It gets even stranger when you consider that incentive packages to businesses typically include tax breaks. (Winston-Salem-based R.J. Reynolds Tobacco Co., for instance, has a tax credit that will save the company an estimated $126 million by 2017, when it’s due to expire.) What that means, of course, is that the state regularly engages in a straight-up swap: It both levies corporate taxes and forgives corporate taxes simultaneously. Now comes the move to reduce the state’s corporate tax rate, but with nary a mention of perhaps giving away incentives with a little less vigor. If this strikes you as an odd way to run a tax system, welcome to the club.